I’m attempting to hit on a few common questions (and, usually, misperceptions) that can help you better understand how the market actually works, which, in turn, will help you make (and keep) more of your money. Some of the questions are market-based, some pertain to individual stocks, but all of them should help you become a better investor.

So, without further ado …

Question: You look for stocks that have held up the best during the market downturns, saying they’ll be the ones that do best once the bulls return. But what about good companies whose stocks are beaten down?

Answer: There are really two answers to this question. In general, yes, if a stock has a great growth story and can’t go down much when the market is heading south, think of it like a coiled spring–it wants to go higher, but the weight of the market is on top of it. Once that weight is relieved (i.e., a new market rally), the stock will spring higher, oftentimes in a hurry.

Yes, the stock that falls 30% or more during a correction will probably have a snapback rally, but unless the stock has formed a bottoming pattern–something that usually takes many weeks–there will be many investors who own that broken stock at higher prices who will be looking to sell as the stock rallies … and that selling will slow down or stop any attempted advance.

More important, though, is that you have to decide what kind of investor you are. I’m sure it’s possible to make money buying beaten-down stocks, but that is not my style. I simply know there are plenty of good opportunities in stocks that hold up well during a market decline, including many that turn into great winners. In other words, I’m not saying my way is the only way, only that I know it’s worked for decades at Cabot.

Question: You often write about buying on weakness, but I’ve found that when a market begins a new rally, many of these resilient stocks (that didn’t fall much during the correction) are extended well above support and key moving averages. So should I try to buy these names on weakness when the market turns up?

Answer: This is a great question and is a perfect example of how, in the stock market, there are no absolutes. Yes, during 80% of a market cycle, it’s usually better to buy stocks that are either pulling back normally toward some support (like the 25-day or 50-day moving average) or decisively breaking out of a well-formed basing structure.

However, when the market has come through a multi-week correction and just confirmed a new uptrend, you’re almost always better off just buying the strongest growth-oriented stocks around. Assuming the market’s new rally is the real McCoy, it’s likely that there are tons of mutual, hedge and pension funds all trying to establish positions in the market’s new leaders. The result? Little in the way of pullbacks for the first two to four weeks.

That’s not to say you shouldn’t adhere to your loss-cutting rules in case something goes awry, but at least for your first couple of purchases, buying the most resilient growth stocks (not defensive stocks like gold or food) as soon as the market gets going is usually a good bet.

Question: I’ve been watching XYZ stock; it’s got all the attributes you look for. And it’s held up well during this decline. Can I buy some now?

Answer: Doing a little new buying during this correction is fine by me, but just remember that, in a bad market, good stocks can go bad in a hurry. Thus, today’s strong stock could crumble before the downturn ends.

Question (follow-up): That makes sense, but what if I wait for a stock to break to new highs?

Answer: Again, it’s OK to nibble and possibly get started on a position ahead of time. But most breakouts in bad markets do not work. Actually, that’s one of my subjective indicators that a correction is over–when a potential leading stock or two break out on big volume, hold those gains, and then continue higher. But the odds favor breakouts failing (sometimes in a hurry) if the trend is down.

Question: Some pundits are saying this is a new bear market. Others are saying it’s a correction. Others are even saying we’re in a long-term bear market that started in 2000 or 2007. What’s your view?

Answer: What I think is that labels are totally, 100% overrated. The major question is this: Is the market environment conducive to buying leading growth stocks? If it is, then I’m buying. If it’s not, then I’m defensive. It really is that simple. Right now, the sellers are in control, so I’m waiting patiently until that changes.

As for all the cyclical bull, secular bear, etc., I advise you to just hit the mute button when you hear that stuff. Supposedly we’ve been in a long-term bear market since 2000, but that didn’t stop investors from making good money during the upmove from 2003-2007 in stocks like XM Satellite Radio, eResearch, eBay, Yahoo!, Taser, Google, Apple, Southwestern Energy, First Solar and Crocs, just to name a few. Heck, even during the early stages of the 2007-2009 bear market, there were opportunities in stocks like Visa and Continental Resources. Thus, let the pundits debate the labels of the market. Your job is to size up the market’s current trend and position yourself accordingly.

(For the record, some of the indicators I follow do suggest this is “just” a correction, not a bear market–but that didn’t stop me from advising my subscribers to move heavily into cash three weeks ago.)

Question: Mike, I respect your indicators and your work, however, what is going to turn this market around? A resolution in Europe? Another financial bailout? What?

Answer: I have no idea, and neither does anyone else. But the good news is that you don’t have to know what will turn the market around–all you need to do is to watch the market’s actions. It will tell you when it’s ready to head higher.

As a brief example, can you tell me what ended the market’s 10% correction in early February? And, for that matter, what caused it to top out in January? Anyone? My point is that the supposed reasons for an advance, decline or turning point aren’t that important. Just stick to the market’s message.

Question: Whenever the market’s turn comes, how will you know it’s the real deal? It seems there are so many promising upmoves that turn into dust within a day or two.

Answer: Well, first, we have a market timing system at Cabot that treats us well. It’s not perfect (no system is), but when our Cabot Tides (intermediate-term trend following indicator) turns positive, that will give the best thumbs up that the rally is for real.

Beyond that, however, the real key I’ve found is your own portfolio–specifically, your portfolio’s balance. Are you making money with your purchases? Are your stocks heading higher with shallow pullbacks? Are your new purchases getting off to good starts? If the answers are yes, then the odds are strong that the rally is for real.

If, however, you buy a couple of stocks and they head south, and then you maybe buy one more, only to see that struggle, then your antennae should be up–no matter what the market timing says, if you can’t make money on your first handful of purchases, it’s possible the market isn’t as strong as it appears.

Long story short, you want the market to “pull” you into a heavily invested position after the trend turns up. And you get pulled in by getting off to good starts on your first few purchases.

Question: I still own a lot of stocks that have broken down badly. I guess I should sell them, but they’re good companies, and the market is already down so much. What should I do?

Answer: This is probably the most common question I’m getting these days. And I do agree that selling a ton of stocks right now, after the market has fallen more than 10% in just a few weeks, isn’t likely the best course of action.

That said, doing nothing and simply hoping your stocks and the market turns around isn’t prudent, either.

So my answer is to split the difference–take some action now by selling a portion of your losers. This will do two things. First, it will get you back in gear with your stocks; you’re selling shares because of the evidence in front of you. And second, it will get you into a proactive mode; you’re not waiting and praying for help, you’re examining the situation and reacting to it

Then, with the rest of your shares, you should formulate a reasonable game plan on how you want to sell the rest of your shares (hopefully after a few days of rallying). Chances are your broken stocks will not be leaders of the next advance, so you’re better off coming up with an exit plan so your money can be better invested elsewhere when the bulls return.

Question: I’ve heard Cabot does a good job of timing the market. My question isn’t what you think of the market, but what is the basis of the system you use to time the market?

Answer: The main focus of our market timing is trend following–we generally look at the major indexes in relation to some key moving averages. If the indexes are above their moving averages, and the moving averages themselves are heading up, we consider the trend to be up. If the indexes are below the moving averages, the trend is down.

Using a trend-following approach can be mentally difficult because it requires you to put your pundit hat off to the side, swallow your ego and any opinions you have, and simply listen to the message of the market. But it provides us with a major advantage: We are guaranteed (yes, guaranteed) never to miss out on a major, prolonged market upmove, and we’re guaranteed never to remain heavily invested during a punishing, sustained bear move.

Of course, sometimes there will be whipsaws (signals that are quickly reversed), but that is a very small price to pay for knowing that you’ll always be on the right side of the market’s major trend. Whether it’s our system or one you develop on your own, I strongly suggest you develop a way to spot major trend changes–it’s sure to significantly boost your results.

Editor’s Note: If you want more of Mike Cintolo’s expert growth stock picking and market timing advice, you should check out Cabot Market Letter today. It uses a system perfected over 40 years to get investors into the top growth stocks when the market is healthy and get subscribers safely on the sidelines when the market turns ugly. Don’t miss another signal. Click here to get started today!

Question: What are some low-risk strategies that I can employ during a market downturn?

Answer: At Cabot, most of our editors practice a system of growth investing that uses market timing to determine when to stay in the market and when to get out. So our advice for a safe investment during market downturns is, for the most part, to stay in cash. Cabot Tides, the primary market timing indicator for our growth newsletters, gave us a sell signal early last fall and we recommended subscribers move to cash by the time the market crashed, leaving their capital preserved to invest in the next bull market.

Cabot Benjamin Graham Value Letter is a low-risk option for conservative investors. Our value-investing newsletter stays fully invested in high-quality companies and bonds that are priced below their intrinsic value in all market conditions. Cabot Benjamin Graham Value Letter Editor J. Royden Ward incorporates an allocation of bonds into subscribers’ portfolios.

Question: Do you recommend any high-yield investments?

Answer: Yes, Cabot publishes Income Digest, which recommends dozens of high-yielding investments each month, including income stocks, bonds, mutual funds and ETFs. Our investment expert selects the very best income investments from hundreds of newsletters to include in each issue. These are the top income investment ideas from the best minds on Wall Street. Here’s an example of one recommendation from a recent issue:

“The pressure is on U.S. automakers to build vehicles that are more fuel efficient. Plug-in electric hybrids are the focus of efforts to achieve that goal. Cars like the Chevy Volt will be able to plug in to a local power source and recharge. The winners here will be electric utilities. Auto manufacturers will make do with the help of subsidies. Taxpayers will be forced to provide those subsidies. Car buyers will have to forgo frills like comfort, cargo space and safety. These plug-in hybrids will need new infrastructure to support them. Outlets for recharging will need to be placed in strategic locations like parking lots, existing gas stations and even driveways. This extension of the existing power grid will generate a regulated monopoly return for utilities like Black Hills Corp. (BKH 22.63 NYQ – yield 6.30%). My relative-strength chart shows that Black Hills outperformed the S&P 500 in 2H08.” Richard C. Young, Intelligence Report, www.intelligencereport.com,
800-301-8968, 12 issues, 2/09

Question: What investments will benefit from the economic stimulus package?

Answer: Two words: Green investments. The economic stimulus package, which was recently signed into law, is going to flood the Green sector with $76 billion, leading to a boost for many companies in this area. President Barack Obama has stated many times that he wants to push Green initiatives, and the stimulus is one way he’s going to be able to do that.

Cabot Green Investor Editor Brendan Coffey sees great things coming down the pipeline for the Green sector as the stimulus begins to take effect. The stimulus will likely benefit several areas of Green, everything from weatherizing homes and cleaning up nuclear weapon production sites to smart electricity and loans for renewable energy projects. There will also be funds for clean energy grants and to make federal buildings more energy efficient.

Another big chunk of money in the economic stimulus package for infrastructure projects could arguably go toward Green, with some of it slated for mass transit and clean water projects. Brendan told his readers to expect more stock market response as it becomes clearer which Green companies will be the big winners.

Question: I want to know more about Green investments. Can you help me?

Answer: Yes, we can! Lately it seems everyone has been talking about Green; from energy to fertilizer, and everything in between, there’s no denying that a revolution is taking place. Cabot Green Investor is the place to find out about fast-growing, earth-friendly investments. All of Cabot’s time-tested growth stock criteria are applied to the stocks in the newsletter to ensure that you are investing in the most promising stocks in this high-potential sector. Brendan Coffey, a veteran financial writer, is the analyst and editor of Cabot Green Investor.

Cabot Benjamin Graham Value Letter, launched in 2003, uses the teachings of Benjamin Graham, the father of value investing, in a system that safely builds long-lasting wealth. Unlike Cabot’s growth publications, the letter doesn’t use market timing, instead relying on a 76-year-old system, followed by investors such as billionaire Warren Buffett, to pick undervalued stocks and hold them until they reach a specified valuation.

Value investing is about finding stocks that the market has not correctly priced, in other words, a stock that is worth more than is reflected in the current price. Value investing has been proven to work well over time when you buy carefully, follow a proven system and hold for the long term. Most subscribers to Cabot Benjamin Graham Value Letter are looking for ways to safely build wealth over the long term. They want the freedom to go on vacation without worrying about their stocks.

The main goal of the Cabot Benjamin Graham Value Letter is to provide you with exceptional stock recommendations using the techniques pioneered by Benjamin Graham. Our second goal, no less important, is to give you the confidence to buy those stocks and the patience to hold them to fruition. If you can achieve those goals, we’re confident that we’ll have a long and prosperous relationship together.

Benjamin Graham wrote two books that formed the basis for his value investing system. Roy recommends both of these to anyone who is interested in learning more about value investing:

Benjamin Graham’s classic book, “Security Analysis,” co-authored with David Dodd, laid the framework for the value investing system. Individuals and Wall Street professionals consider the timeless book, published in 1934, an investing bible. “Security Analysis” thoroughly explains Graham’s value investing methods, including how to value stocks, the margin of safety and guidelines for successful investing.

Benjamin Graham also penned “The Intelligent Investor” in 1949, and the book has since been called “by far the best book on investing ever written,” by Warren Buffet, one of Graham’s students and followers. Roy uses the criteria outlined in this book to select the stocks for the Classic Benjamin Graham Model Porfolio in the Cabot Benjamin Graham Value Letter.

Now, for the Q&A …

Question: What are your thoughts about the wild year of 2008?

Answer: Good riddance is my initial thought.  But 2008 shouldn’t be dismissed without further examination.  As a value investor, I pay less attention to the ups and downs of charts, the economy and the stock market.  Rather, I focus on the most undervalued stocks with solid long-term potential.  Recommending the most undervalued stocks in 2008, however, produced mediocre results as undervalued stocks became more undervalued since then.  I have changed one of our methodologies in Cabot Benjamin Graham Value Letter and I’m happy to report that our new method is working very well.  During the last six weeks, the Classic Benjamin Graham Value Model has increased 13.4% compared to a decline of 7.1% for the Dow Jones Industrial Average!

Question: What is your outlook for the stock market in 2009 and beyond?

Answer: The stock market below 9,000 is clearly undervalued.  My forecast calls for a test of the November lows, followed by a slow stock market recovery in the second half of 2009.  Be prepared for volatility, though.  My outlook beyond 2009 is positive.  The U.S. and other economies around the world will begin to recover.  A new bull market will evolve before the economy starts its recovery.  We will look back at this current debacle as the buying opportunity of a lifetime.

Question: What is your outlook for value stocks in 2009 and beyond?

Answer: Value stocks have more potential than growth stocks during the next year or so.  Long term (three to five years) prospects are excellent.  Most investors, including the professionals, base their decisions on the outlook for the next six to 12 months.  I prefer to look at a company’s prospects in three to five years.  The question is simple: Will the company be noticeably larger and more profitable three, four and five years from now?

Question: What’s one of your favorite value stocks right now and why?

Answer: To pick just one is extremely difficult.  There are so many factors (many of them unforeseen) that can affect the future price of a stock, and I always urge diversification, too.  Therefore, I’ll give you two good stocks that are clearly undervalued: Bucyrus International (BUCY) and Transocean (RIG).  Chances are very good that at least one of these companies will live up to its potential and the other will perform reasonably well.

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Bucyrus International (BUCY) is a leading international manufacturer of large-scale surface and belowground mining equipment, parts and services for mining coal, iron ore, copper, oil sands and other commodities.  A strong order backlog and new infrastructure demands from around the world will produce rapid 21% earnings growth during the next three to five years.  BUCY shares are grossly undervalued at 5.4 times current earnings per share (EPS).

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Transocean (RIG) is the world’s largest offshore drilling contractor with 66 deep-water drilling rigs and 68 shallow-water rigs working in all of the major offshore regions.  The company’s 2007 acquisition of Global Santa Fe added substantial debt to RIG’s balance sheet, but RIG is paying down the debt rapidly and should be in a position to begin paying dividends before the end of 2010.  EPS soared 67% in 2008 and will climb another 15% in 2009.  EPS growth is propelled by higher rental rates for deep-water rigs and a huge $41 billion backlog of contracts.  I believe oil prices will increase in 2009, which will help RIG even further.  At 3.3 times current EPS, RIG shares are an outstanding bargain.

Question: I’ve waited patiently for a new bull market.  Once it arrives, what’s the best way to take advantage of it?  Should I become fully invested immediately?  Buy leveraged ETFs?  A mixture of both?

Answer: There is no one perfect way to play the market … but the key is to have a game plan going in.  For my part, I’m a big fan of taking things slow. I know most investors, especially if they’ve waited out much of the bear market on the sideline (as have my subscribers), are eager to get back in, and make sure they don’t “miss the boat.”

But I’ve got news for you:  Any new bull market is going to last months and years, not two or three weeks.  And my studies of the past have shown that many of the best winners don’t come off the launching pad until a few weeks after the bottom.  That is certain to be the case this time around, as the number of good-looking growth stocks capable of leading this market higher is currently tiny–I would say fewer than five.

Thus, when buy signals come, it’s best to put some money to work, and then observe.  If your stocks don’t go up, don’t buy any more.  But if the market acts well, and your new purchases get off to good starts, you can look to average up on those purchases, or add another stock or two to your portfolio.  And then go from there.

As for what to buy, that’s really a matter of personal preference.  I like to find individual stocks that can double, triple or more at the start of a new bull market.  And I run a fairly concentrated portfolio–usually no more than eight stocks.  But there’s nothing wrong with using index or sector ETFs, but the same principles apply; cut all losses short, let winners run, and only buy more if your portfolio is advancing.

Question: What are some prudent ways of shorting stocks if this downtrend continues?

Answer: Shorting is more difficult than buying for one main reason–fear is a more intense emotion than greed, and thus, drops tend to happen more quickly than rises.  That means your timing on short sales must be more precise than your timing on long investments.

Still, shorting can be done profitably.  The keys are: To short past leaders that had huge upmoves, are well known and very liquid; to short only after a definitive top in the stock (and the market) is in place; to short AFTER a multi-week rally, generally up to the 50-day moving average; and to take both losses and profits quickly.  You don’t want to wait around for a huge rally in the stock; you’re better off nailing down 20% to 30% profits on the short side.

The other option, if you want to take out the risk of individual stocks, is to short exchange traded funds (ETFs) of indexes like the Dow or S&P 500, or if you want more risk, buy the inverse ProShares of those same indexes (symbols DXD and SDS, respectively).  Again, just remember to short after rallies, not after a few weeks of declines.